Legislation and Policy BriefVolume 1Issue 2 Spring 2009 - An Economy in Crisis: WhatCan Be Done?

Article 3

9-24-2010

ARMed and Dangerous: the Crime of MortgageFraud and What Congress Must Do to Stop ItGabriel ZitrinAmerican University Washington College of Law, gz4181a@student.american.edu

Follow this and additional works at: http://digitalcommons.wcl.american.edu/lpbPart of the Administrative Law Commons, Banking and Finance Commons, Consumer

Protection Law Commons, Housing Law Commons, Legislation Commons, and the PoliticsCommons

This Article is brought to you for free and open access by the Washington College of Law Journals & Law Reviews at Digital Commons @ AmericanUniversity Washington College of Law. It has been accepted for inclusion in Legislation and Policy Brief by an authorized administrator of DigitalCommons @ American University Washington College of Law. For more information, please contact fbrown@wcl.american.edu.

Recommended CitationZitrin, Gabriel (2009) "ARMed and Dangerous: the Crime of Mortgage Fraud and What Congress Must Do to Stop It," Legislation andPolicy Brief: Vol. 1: Iss. 2, Article 3.Available at: http://digitalcommons.wcl.american.edu/lpb/vol1/iss2/3

THE LEGISLATION AND POLICY ROUNDTABLE

AN ECONOMY IN CRISIS: WHAT CAN BE DONE?

VOLUME 1, ISSUE 2 SPRING 2009

The Legislation and Policy Roundtable Volume 1, Issue 2, Spring 2009

29

ARMed and Dangerous: the Crime of Mortgage Fraud and What Congress Must Do to Stop It

Gabriel Zitrin

On February 18, 2009, President Barack Obama put forth a $75 billion mortgage rescue

plan to assist homeowners who have defaulted or are in danger of defaulting on their mortgages.1

The plan was greeted with outright horror by conservative think-tanks,2 Republicans in

Congress,3 and any number of people who fall sharply on the other side of the long-running

national debate regarding the role of government in assisting those who have fallen upon hard

times in the free market system. In his opposition to the plan, CNBC trading analyst Rick

Santelli famously went so far as to characterize defaulting homeowners as “losers” during a

widely-publicized on-air explosion.4

On a different plane, the aggregate microeconomic catastrophes of widespread mortgage

defaults have taken on a potent macroeconomic significance in the wake of the economic

downturn of 2007. The largely unnoticed rise of mortgage-backed securities over the last twenty

years gradually tied the fortunes of more and more private investors to the ability of the

individual mortgage-holder to keep his head above water. While now common knowledge, these

severe and far-reaching financial consequences are being dealt with at the usual glacial pace of

the federal government.

1 Phil Mintz, Obama Sets $75 Billion Mortgage Rescue Plan, BUSINESSWEEK, Feb. 18, 2009, http://www.businessweek.com/bwdaily/dnflash/content/feb2009/db20090218_5 82414.htm. 2 See, e.g., Matt Kibbe, Top 10 Reasons to Oppose the Obama Housing Bailout, FREEDOMWORKS, Feb. 20, 2009, http://www.freedomworks.org/publications/ten-reasons-to-oppose-the-obama-mortgage-bailout. 3 See, e.g., Walter Alarkon, Cantor Criticizes Obama Mortgage Aid, THE HILL, Feb. 16, 2009, http://thehill.com/leading-the-news/cantor-offers-early-criticism-of-obama-mortgage-aid-plan-2009-02-16.html; Rep. Spencer Bachus, Statement on Housing Bailout, Cram-Down Legislation, Feb. 26, 2009, http://republicans.financialservices.house.gov/news/PRArticle.aspx?NewsID=323. 4 Tracy Connor, The Case Against the Mortgage Bailout: 'We're Rewarding the Losers', N.Y. DAILY NEWS, Feb. 20, 2009, http://www.nydailynews.com/money/2009/02/19/2009-02-19_the_case_against_the_mortgage_bailout_we.html.

The Legislation and Policy Roundtable Volume 1, Issue 2, Spring 2009

30

For some time it was apparent that few in position to enact measures combating the

mortgage crisis fully grasped its severity. On April 17, 2007, for example, the Senate Banking

Subcommittee on Securities, Insurance and Investment held a hearing on the role of

securitization in the sub-prime mortgage crisis. Subcommittee chair Senator Jack Reed (D-RI)

sounded sensible enough in recounting the “dramatic increase in home loan delinquencies and

foreclosures [and] the closure or sale of over 40 subprime lenders...in recent months.”5

But had the senator and his staff realized the full extent of the damage already done and

the torrent that would follow, the banking industry presumably would not have been represented

at this hearing by, among others, Gyan Sinha, Senior Managing Director at Bear Stearns, and

David Sherr, Managing Director and Head of Securitized Products at Lehman Brothers. Bear

Stearns was sold to JP Morgan for a pittance less than a year later,6,7 not long before Lehman

Brothers filed for the largest bankruptcy in American history, listing $613 billion in debt.8

Senator Reed apparently did not anticipate these two mammoth institutions joining the ranks of

the defunct in the near future, and this hardly represents a lack of foresight on his part, so much

as the shocking severity of the downturn.

While advocacy of mortgage securitization reform could fill many pages, this article will

not utilize much space discussing it here. Instead, it will simply argue that while the relevant

monetary policymakers continue far too slowly in the pursuit of mortgage securities reform,

lawmakers whose purview includes the housing sector should use this opportunity to pursue a

5 Subprime Mortgage Market Turmoil: Examining the Role of Securitization Before the Subcomm. on Securities, Insurance, and Investment of the S. Comm. on Banking, Housing and Urban Affairs, 110th Cong. (2007) (statement of Sen. Jack Reed (D-RI), subcommittee chair). 6 Andrew Ross Sorkin, JP Morgan Pays $2 a Share for Bear Stearns, N.Y. TIMES, Mar. 17, 2008, http://www.nytimes.com/2008/03/17/business/17bear.html. 7 Landon Thomas Jr. and Eric Dash, Seeking Fast Deal, JPMorgan Quintuples Bear Stearns Bid, N.Y. TIMES, Mar. 25, 2008, http://www.nytimes.com/2008/03/25/business/25bear.html. 8 Sam Mamudi, Lehman Folds With Record $613 Billion Debt, MarketWatch, Sept. 15, 2008, http://www.marketwatch.com/news/story/story.aspx?guid={2FE5AC05-597A-4E71-A2D5-9B9FCC290520}.

The Legislation and Policy Roundtable Volume 1, Issue 2, Spring 2009

31

two-part strategy of aggressively combating fraud in the terms and sales of individual mortgages

and taking bold measures to ensure that not simply embattled mortgage-holders but the victims

of fraudulent lending behavior can achieve financial sustainability, even as they keep ownership

of their homes.

The Dream of Home Ownership

Home ownership plays a very powerful role in how Americans think of what

differentiates our country from the rest of the world. In every corner of the country, Americans

continue to speak and think of home ownership as a right earned no less by virtue of American

citizenship than those of free speech, due process or a voice in the selection of our leaders.9 It is

long past time for lawmakers to recognize that this uniquely American cultural drive weighs

heavily on many prospective homebuyers, and in fact culturally conditions us to overexpose

ourselves in purchasing a home.

It should not be believed that this cultural conditioning is so powerful a force as to

eliminate a homebuyer’s responsibility for his own mental processes when evaluating whether or

not he can afford to purchase a particular home. But while there is no denying the role of

personal responsibility, it is preposterous to contend that the mortgage industry does not exploit

the especially American dream of home ownership, in its marketing strategies and in its overall

contributions to the national dialogue, in the quest for the maximum number of borrowers

possible, and the riskiest loans at the highest interest rates.

As put so succinctly by journalist Joe Bageant, “[T]he biggest organized racket in the

United States rests upon the dream of owning one’s own home. Hundreds of legally sanctioned

9 See, e.g., Possible Responses to Rising Mortgage Foreclosures Before the H. Comm. on Financial Services, 110th Cong. 110-21 157 (2007) (statement of George P. Miller, Executive Director, American Securitization Forum).

The Legislation and Policy Roundtable Volume 1, Issue 2, Spring 2009

32

scams operate under this ruse. Our economy depends upon continuous expansion of housing

construction and financing of all types.”10 But widespread home ownership is a threefold

objective: not only did it push the American economic bubble perilously outward, not only does

it feature prominently in our national identity as “one of the most widely shared values in

America and an iconic symbol of personal achievement,”11 but it also has the potential to make a

lot of money for people who are good at securing home loans for others.

“[A]s the housing bubble inflated, wholesalers—though hidden from public view—

became high-earning superstars. [Sharmen] Lane, a manicurist before joining now-defunct

subprime lender New Century Mortgage in 1997, says she brought home $1 million in 2002 and

$1.2 million in 2003.”12 Or, as a mortgage broker that Bageant interviewed put it, “Where else

could a guy like me, with no education beyond high school, make $66,000 a year working only

twelve hours a week?”13

The more loans a mortgage broker is able to secure, the more money he makes,

regardless of whether he accurately depicts the buyer’s ability to pay. This creates an industry-

wide incentive to stretch a buyer’s purchasing power completely beyond recognition or the

bounds of good faith. The end result, as described by Bageant, should surprise no one: “A

complex and nasty circle of credit racketeering by the mortgage and banking businesses based

upon conditioned consumer stupidity and millions of very shaky credit applications.”14

10 JOE BAGEANT, DEER HUNTING WITH JESUS: DISPATCHES FROM AMERICA’S CLASS WAR 106, (2007). 11 Possible Responses to Rising Mortgage Foreclosures, supra note 9. 12 Mara Der Hovanesian, Sex, Lies and Subprime Mortgages, BUSINESSWEEK, Nov. 13, 2008, http://www.businessweek.com/magazine/content/08_47/b4109070638235.htm. 13 Bageant, supra note 10, at 99. 14 Id. at 104.

The Legislation and Policy Roundtable Volume 1, Issue 2, Spring 2009

33

The Nightmare of Foreclosure

Faced with the first signs of the crisis it would eventually suffer, the mortgage industry

itself bravely declined to see a problem. Instead, in a familiar-sounding opus to free-market

principles and that same clarion call of home ownership, David Sherr of Lehman Brothers

testified before Senator Reed’s subcommittee on April 17, 2007, that “[b]ecause none of the

participants in the securitization process benefit from foreclosures, the market has evolved, and

will continue to evolve, so as to minimize the number of foreclosures.”15

Just calling this statement “wrong” does not begin to do it justice. Foreclosure activity

for the year 2007, during which Sherr offered his prognostication, rose 75% nationwide from its

number in 2006, including 238% in California, 456% in Virginia, and 608% in the District of

Columbia.16 In 2008, the increase was an additional 81% over those same 2007 levels.17

Consider Sherr’s testimony in a different light: not as having been given eight months

before the 2007 foreclosure rates became final, but eighteen days after the Mortgage Bankers

Association, an industry collective of which Lehman Brothers was a member, reported not only

that nationwide foreclosure rates had reached a record high, but that the worst of the problem

was yet to come.18

Three days before that report was released, the Association’s Chairman, John Robbins,

grudgingly acknowledged in testimony before the corresponding House committee that

“Responsible lenders...do not trick borrowers into loans that are unsustainable. And they do not

15 Subprime Mortgage Market Turmoil: Examining the Role of Securitization Before the Subcomm. on Securities, Insurance, and Investment of the S. Comm. on Banking, Housing and Urban Affairs, 110th Cong. (2007) (statement of David Sherr, Managing Director and Global Head of Securitized Products, Lehman Brothers Inc.). 16 RealtyTrac, U.S. Foreclosure Activity Increases 75% in 2007 (2008), http://www.realtytrac.com/ContentManagement/pressrelease.aspx?ChannelID=9&ItemID=3988&accnt=64847. 17 RealtyTrac, Foreclosure Activity Increases 81% in 2008 (2009), http://www.realtytrac.com/ContentManagement/pressrelease.aspx?ChannelID=9&ItemID=5681&accnt=64847. 18 Noelle Knox, Record Foreclosures Hit Mortgage Lenders, USA TODAY, Mar. 30, 2007, http://www.usatoday.com/money/economy/housing/2007-03-13-foreclosures_N.htm.

The Legislation and Policy Roundtable Volume 1, Issue 2, Spring 2009

34

hold out something that is only a mirage of the American Dream. Yet bad loans were made.

They were not made responsibly or with the best interest of consumers in mind.”19 Astute

readers will note that here Mr. Robbins chose to employ the passive voice to concede that bad

loans “were made,” as if all by themselves. This trick neatly absolves any individual entity of

any responsibility.

It is astonishing that any industry representative could really be so oblivious as to what

was happening in his own industry in the middle of its extremely rapid unraveling. What

economic indicator could Sherr possibly have cited during his testimony in an effort to illustrate

just how well things were going in April of 2007?

Careful readers may have already guessed: “If not for the innovation of mortgage

securitization, the United States would not have become the nation of homeowners that it is

today, with homeownership close to its highest level in our history – almost 70 percent

overall.”20

What did Mr. Robbins have to say on the subject?

“Homeownership is near its highest level in history – nearly 70 percent overall… As a result of these increases in homeownership, across all demographics, Americans are building tremendous wealth by increasing their home equity through their monthly payments and through the impressive rate of home price appreciation seen in recent years.”21

This coming three days before the Association of which he was Chairman reported that the rate

of foreclosures nationwide had hit a new record.

19 Subprime and Predatory Lending: New Regulatory Guidance, Current Market Conditions, and Effects on Market Conditions Before the Subcomm. on Financial Institutions and Consumer Credit of the H. Comm. on Financial Services, 110th Cong. (2007) (statement of John Robbins, Chairman of the Mortgage Bankers Association). 20 Subprime Mortgage Market Turmoil, supra note 15. 21 Subprime and Predatory Lending, supra note 19.

The Legislation and Policy Roundtable Volume 1, Issue 2, Spring 2009

35

Was Robbins cognizant of the findings of this report? In a word, no. “While overall

delinquencies rose in the fourth quarter of 2006, assertions that delinquency rates are at crisis

levels and a greater percentage of borrowers are losing their homes are not supported by data. In

fact, delinquency and foreclosure rates have remained relatively low with increases over the last

year.”22

Neither the mortgage industry nor Congress can see any correlation between record levels

of homeownership and record numbers of foreclosures. In their view, this must all be a

spectacular coincidence.

Not everyone in the upper echelons of our nation’s economic hierarchy has proven so

impossibly dense, at least not after the fact. “The Bush administration took a lot of pride that

home ownership had reached historic highs,” said former Secretary of the Treasury John Snow,

“but what we forgot in the process was that it has to be done in the context of people being able

to afford their house. We now realize there was a high cost.”23 It is less certain that men such as

Scherr and Robbins arrived at this revelation even in the wake of all that has occurred since their

pronouncements.

Truthfully, it serves little purpose to chastise the Bush administration, Congress, or even

the mortgage industry for failing to see the nature of the correlation between the dream of home

ownership and the nightmare of foreclosure as clearly as did the Joe Bageants of the world.24

What is critical now is to avoid exacerbating the mistakes of the past by failing to take adequate

steps to prevent their repetition in the future. 22 Id. at 15. 23 Jo Becker, Sheryl Gay Stolberg, & Stephen Labaton, Bush Drive for Home Ownership Fueled Housing Bubble, INT’L HERALD TRIB., Dec. 21, 2008, http://www.iht.com/articles/2008/12/21/business/admin.php. 24 Indeed, it would likewise be unfair to characterize the Bush administration’s drive for home ownership for its own sake as having been a departure from similar policies in the past under both Republican and Democratic presidents. The Bush administration, however, chose to pursue the policy at the tail end of an economic boom, as opposed to the administration of President Bill Clinton, which began to implement its policies during a period of much lower housing prices.

The Legislation and Policy Roundtable Volume 1, Issue 2, Spring 2009

36

HASP: Taking a Stand Against Mortgage Fraud - Or Not.

A major piece of any plan to protect homeowners from foreclosure must be an emphasis

on those homeowners whose applications were in some way fraudulent, though such a

determination will most likely only be feasible for future cases. These homeowners have been

victimized for chasing the American dream, and it is difficult to imagine their role in the fraud

itself as having been anything more than secondary to the professionals who not only know the

tricks of the trade that will get a mortgage approved, but also take a tangible profit from the

resulting transaction.

In focusing borrower assistance on the victims of mortgage fraud, active victims though

they may have been, the federal government would be sending the message that it will not

tolerate either the everyday exploitation of the American dream of home ownership or the plainly

criminal acts in which that exploitation can take shape.

But President Obama’s proposed housing plan, officially the Homeowner Affordability

and Stability Plan (HASP), makes no mention of fraud. It therefore treats equally those

homeowners who have defaulted or are in danger of defaulting no matter the degree to which

their mortgage applications were massaged by their brokers to squeeze through the tight bars of

legality, or if the applications were completely legal and honest. An emphasis on the victims of

fraud would not only best serve the interests of justice, but would reduce the risk of incentivizing

reckless behavior that remains one of HASP’s biggest sticking points.25

In the absence of any mention of mortgage fraud in HASP, it is anyone’s guess how

much the administration ever even intended this plan to assist the victims of mortgage fraud, and

how much was simply aimed at any and all homeowners who meet its listed criteria. How

disappointed can we be at the lack of any such distinction? Absent any official estimation of the 25 Bachus, supra note 3.

The Legislation and Policy Roundtable Volume 1, Issue 2, Spring 2009

37

prevalence of fraud in the origination of mortgages that wound up in default, the administration

has no ability to craft a plan designed to prevent such behavior and its deleterious effect on

American families and the economy at large.

Why are the President and Congress, to say nothing of state and local governments, so

powerless to repair the damage done by fraudulent mortgages? Because without an institution

tasked with this very duty, no government, local, state or federal, has the resources to make the

distinction on even the most cursory level between a defaulting buyer whose ability to afford

their home was fraudulently overstated, and one who has simply suffered the way so many have

in these difficult economic times.

Assessing the Prevalence of Fraudulent Mortgages - Or Not.

Unfortunately, as the reader may have noticed, evidence of mortgage fraud at this

juncture is virtually all anecdotal, even if it paints a picture of an epidemic. Neither Joe Bageant,

nor BusinessWeek, nor the Chicago Tribune have any way of demonstrating the full extent to

which fraudulent mortgages have exposed a vulnerable financial sector, and ruined the finances

of American families.

The Mortgage Asset Research Institute’s most recent Quarterly Fraud Report estimates

that mortgage fraud rose 45% in the second quarter of 2008 from the same period in 2007,26 but

makes no attempt to gauge what portion of the total mortgage market was affected.

Be you a second-year law student or the former Treasury Secretary, a respected business

publication, major daily, or intrepid independent journalist, you will find it difficult to expose the

evils of mortgage fraud because of a lack of hard evidence about its prevalence, no matter how

26 Quarterly Fraud Report, 2Q 2008, Mortgage Asset Research Institute, Dec. 2, 2008 http://www.marisolutions.com/pdfs/mba/mortgage-fraud-report-2008Q2.pdf.

The Legislation and Policy Roundtable Volume 1, Issue 2, Spring 2009

38

powerful and seemingly damning your anecdotal evidence may be, or how much of it can be

assembled. For example:

“Court documents and interviews with scores of industry players suggest that wholesalers also offered bribes to fellow employees, fabricated documents, and coached brokers on how to break the rules. And they weren't alone. Brokers, who work directly with borrowers, altered and shredded documents. Underwriters, the bank employees who actually approve mortgage loans, also skirted boundaries, demanding secret payments from wholesalers to green-light loans they knew to be fraudulent. Some employees who reported misdeeds were harassed or fired.”27

“We are talking pure lizard sleaze… Dealers falsify down payment information on credit

applications, fake the terms and the price, and add on inflated fees from the word go.”28

“The key is to refinance borrowers whose current loans involved fraud in the origination

process. And I assure you it was a minority of borrowers whose loans didn’t involve fraud.”29

“At the crisis' core are loans that were made with virtually nonexistent underwriting

standards - no verification of income or assets; little consideration of the applicant's ability to

make payments; no down payment.”30

“A former Wells Fargo wholesaler says he regularly used the copiers at a nearby Kinko's

to alter borrowers' pay stubs and bank account statements. He would embellish job titles --

turning a gardener, for instance, into the owner of a landscaping company -- and inflate

salaries.”31

27 Der Hovanesian, supra note 12. 28 Bageant, supra note 10, at 107. 29 Sean Olender, Mortgage Meltdown: Interest Eate 'Freeze' - The Real Story is Fraud, S.F. CHRON., Dec. 9, 2007, http://www.sfgate.com/cgibin/article.cgi?f=/c/a/2007/12/09/IN5BTNJ2V.DTL&hw=Sean+Olender&sn=007&sc=593. 30 Stan Liebowitz, The Real Scandal: How Feds Invited the Mortgage Mess, N.Y. POST, February 5, 2008, http://www.nypost.com/seven/02052008/postopinion/opedcolumnists/the_real_scandal_243911.htm. 31 Der Hovanesian, supra note 12.

The Legislation and Policy Roundtable Volume 1, Issue 2, Spring 2009

39

“I'd walk into mortgage shops and see brokers openly cutting and pasting income

documents and pay stubs, getting out the Wite-Out and changing Social Security numbers.”32

“A real estate appraiser would appraise the homes at inflated prices, prosecutors said.

Then, Navascues would fill out fraudulent loan applications exaggerating the buyer's financial

means.”33

“During the boom, many lenders, including Countrywide, gave borrowers loans without

requiring them to document their income. It was widely assumed that many of the borrowers

didn't document their incomes because they were lying.”34

One could go on and on and on, but as long as the mortgage industry is prepared, as they

undoubtedly are, to argue that despite such sensational stories, fraud is not a major cause of the

foreclosure crisis, and as long as the federal government is making no attempt to find out

whether this argument has any merit, we might as well move on.

32 Id. 33 David Heinzmann, Loan Plot Allegations Grow: Bank Sues to Recover Lost Money, Accuses Lincolnwood Firm of Mortgage-fraud Scheme, CHI. TRIB., Nov. 19, 2006, at C1. 34 David Streitfeld, Countrywide Chief Sees ‘Opportunity’, L.A. TIMES, Sept. 19, 2007, at C3.

The Legislation and Policy Roundtable Volume 1, Issue 2, Spring 2009

40

It is not entirely correct that no one has made an effort to list the various causes of

foreclosures. Freddie Mac’s 2006 (pre-crisis) analysis of its own portfolio yielded the

following35:

CHIEF CAUSES OF MORTGAGE DELINQUENCY 2001-2006 Cause 2001-2005 2006* Unemployment or Loss of Income 42.8% 36.3% Illness in the Family 19.2% 21.1% Excessive Obligation 11.1% 13.6% Marital Difficulties 7.9% 6.0% Death in the Family 3.7% 3.9% Property Problems or Casualty Loss 1.7% 2.8% Extreme Hardship 2.8% 0.9% Inability To Sell Or Rent Property 1.3% 1.4% Employment transfer or military service 0.9% 0.6% All other reasons 8.7% 13.3% *Excludes delinquent loans in Louisiana and Mississippi due to the effects of the 2005 hurricanes. Mortgage fraud is not listed here alongside the sorts of causes of foreclosures that have

been in the industry’s consciousness for much longer. What we have instead is a list of potential

causes for delinquency that will all be made more likely if the buyer’s ability to withstand them

has been overstated at the origination of the mortgage (though one may ask whether “excessive

obligation” means what it seems to mean, and if not, what they could mean by this term).

35 Freddie Mac, 2006 Drop in Delinquencies Show Shifting Reasons Behind Single Family Late Payments, http://www.freddiemac.com/news/archives/servicing/2007/20070425_singlefamily.html.

The Legislation and Policy Roundtable Volume 1, Issue 2, Spring 2009

41

Countrywide Financial, which was the nation’s largest mortgage broker36 up until its

spectacular collapse,37 released a similar portfolio analysis in September of 2007.38

So what's driving foreclosures? Here is Countrywide's breakdown -- based on information from its servicing portfolio -- when "cause of foreclosure" is known (80.3%), the breakdown is as follows: -- Curtailment of income: 58.3% -- Illness/Medical: 13.2% -- Divorce: 8.4% -- Investment Prop./Unable to sell: 6.1% -- Low regard for property ownership: 5.5% -- Death: 3.6% -- Payment adjustment: 1.4% -- Other: 3.5%

This may be a different source, but it tells the same story. Fraudulent mortgage

applications make delinquencies more likely even though in lists such as these they will be

tucked into other categories, because at the moment no one has the wherewithal to give them

their own.

Minnesota, California and the Illusion of Action

Efforts to combat mortgage fraud have produced a checkerboard pattern across the states,

but the predominant legal condition mirrors the absence of any reference to mortgage fraud in

the federal code. New York, Pennsylvania, Ohio and Illinois, for instance, do not yet have

provisions to punish mortgage fraud.

Minimal concrete efforts have been made in some states, such as Minnesota and

California, that hardly inspire confidence that they will make a huge difference in combating the

36 Streitfeld, supra note 34. 37 For a general overview of Countrywide’s fall, see David Ellis, BofA inks deal to buy Countrywide for $4 billion, CNNMONEY.COM, Jan. 11, 2008, http://money.cnn.com/2008/01/11/news/companies/boa_countrywide/index.htm. 38 Peter Viles, What Causes Foreclosure? Countrywide’s Claims, L.A. TIMES, L.A. Land Blog, Sept. 19, 2007, http://latimesblogs.latimes.com/laland/2007/09/what-causes-for.html.

The Legislation and Policy Roundtable Volume 1, Issue 2, Spring 2009

42

problem. These efforts are preferable to the complete inaction found elsewhere, but woefully

insufficient in the face of today’s nationwide mortgage crisis. The Minnesota statute states that:

(a) No person acting as a residential mortgage originator or servicer, including a person required to be licensed under this chapter, shall… (9) make or cause to be made, directly or indirectly, any false, deceptive, or misleading statement or representation in connection with a residential loan transaction including, without limitation, a false, deceptive, or misleading statement or representation regarding the borrower's ability to qualify for any mortgage product[.]39

The good news out of Minnesota is that the drafters of this law clearly have a good idea

of the form that fraudulent mortgage applications frequently take, and have taken a very simple

step to outlaw it. They understand that some foreclosures, even if they don’t know exactly how

many, are products of the overstatement of the buyers’ ability to pay, and by extension, perhaps

they even recognize the connection to the exploitation of the American dream of home

ownership. The federal government needs to recognize the interconnectedness of these factors,

and to enact legislation that reflects this understanding.

Of course, it should stand out immediately that there are no penalties incurred by

violating the Minnesota law, except impliedly the loss of one’s mortgage broker’s license in the

state of Minnesota, and even that isn’t specified.40 Given that between 2006 and 2008, the

number of properties foreclosed upon in Minnesota rose 336%,41 the state of Minnesota owes its

citizens the protection of criminal and civil penalties attached to this specific statute.

Mortgage fraud is far from the exclusive cause of the 336% increase, but to add penalties

to the statute costs nothing, and if they prevent even one further instance of fraud, or properly

39 MINN. STAT. § 58.13 (2009). 40 This is consistent with the rest of the broker’s code of conduct that comprises § 58.13. For an example of a similar statute, see OR. REV. STAT. § 59.971 (2008). 41 RealtyTrac, Foreclosure Activity Increases 81% in 2008, supra note 17.

The Legislation and Policy Roundtable Volume 1, Issue 2, Spring 2009

43

punish one person for ruining a family’s finances, possibly even giving that family a way to

recoup their losses, it will have been a good and useful law.

The second problem with the Minnesota statute is that it remains general enough to leave

some potential loopholes. For example, the section “regarding the borrower's ability to qualify

for any mortgage product” could be made far more specific, and in fact tailored to the

information contained in a real mortgage application. The anecdotes of sleazy behavior above

provide excellent examples of more specific conduct to be made illegal: the failure to describe a

buyer’s profession in good faith, the alteration of a payroll document, or keeping oneself

deliberately ignorant of a buyer’s true financial state. The current language of the Minnesota

statute prohibits the making of a deceitful statement, thus not forbidding any of the above

examples. These and a great many other underhanded tactics need to be specifically forbidden

by law, not to mention penalized.

The protections of this statute are not weak because the Minnesota legislature failed to

think of any stronger ones, nor because they had heard no stories from their constituents about

the specific methods that certain mortgage brokers have discovered to manipulate the system. Far

more likely, they simply see no reason to heighten the specificity or the sanctions of a totally

unenforceable statute.

Imagining for a moment that section 58.13 imparted criminal liability, who would

realistically be prosecuted for violating it? The actions that it makes unlawful take place well

below where the gaze of the state can fall, and an individual dishonest mortgage broker in

Minnesota, or anywhere else, can currently victimize and falsify with almost total impunity.

The Legislation and Policy Roundtable Volume 1, Issue 2, Spring 2009

44

California, the nation’s most populous state, positively brutalized by the mortgage

meltdown, has language that comes with penalties attached, and yet is probably on the whole

even less stringent than the law in Minnesota. The California statute reads:

A person who originates covered loans shall not make or arrange a covered loan unless at the time the loan is consummated, the person reasonably believes the consumer, or consumers, when considered collectively in the case of multiple consumers, will be able to make the scheduled payments to repay the obligation based upon a consideration of their current and expected income, current obligations, employment status, and other financial resources, other than the consumer's equity in the dwelling that secures repayment of the loan. [Emphasis added.]42

Proving, to the degree required for a criminal conviction or civil liability, that the loan

originator lacked such a reasonable belief is an extremely tall order. While there are no readily-

available statistics on how many people have been charged with a violation of, or sued under,

this statute, it is difficult to imagine the number being very high.

And the penalties attached? A fine of up to $2,500, civil liability to the state capped at

$25,000, and civil liability to the victimized party in the amount of actual damages suffered or

$15,000, whichever is greater, plus attorneys’ fees and costs.43 How many prosecutors, or

plaintiffs’ lawyers representing mortgage fraud victims, will look at this statute and conclude that

pursuing this matter isn’t a complete waste of time? Who can pay their attorneys to pursue this

action, having just lost their home to foreclosure? Who, realistically, will take up the challenge

of proving a lack of reasonable belief in the hopes of recouping actual damages? A legal remedy

so inadvisable to pursue is no remedy at all. Action by a state legislature must provide

constituents with a realistically useful recourse to the law. What this statute provides is nothing

more than the illusion of action.

42 CAL. FIN. CODE § 4793(f)(1) (2009). 43 CAL. FIN. CODE § 4978(a) (2009).

The Legislation and Policy Roundtable Volume 1, Issue 2, Spring 2009

45

While a more cynical observer might ascribe sinister motives to the California legislature,

such as the desire to grant unscrupulous mortgage brokers the same free license they would

enjoy in the absence of any statute at all, it seems logical that the penalties are so weak for the

same reason that there are no penalties in Minnesota – as long as the state lacks the resources to

investigate the transactions themselves, and as long as a victorious civil suit is so unlikely, giving

the statute more teeth would serve no purpose.

Lenient Penalties, Harsh Penalties, and from Washington, Silence

The sad fact is that no matter how stiff a state were to make penalties for mortgage fraud,

without a way to enforce them, the statutes serve little purpose. Such penalties do exist: besides

California, Oklahoma subjects violators to a fine of up to $1,000, which was hopefully a lot more

money when the law was enacted in 1968, and/or imprisonment of up to one year.44 These

penalties are still far below what any victim of mortgage fraud would consider just.

Maryland, in 2008, passed almost unanimously45 the only state law in the nation that

seems to indicate a proper understanding of how severely mortgage fraud should be punished.

Violating this law comes with a felony conviction, civil liability for up to three times the

damages suffered, and most importantly, up to ten years imprisonment, or more under the

aggravating circumstances of a pattern of behavior or the exploitation of a vulnerable adult

victim.46 The definition of what comprises mortgage fraud is also considerably more detailed

than it is in Minnesota and elsewhere. But despite the hard stand taken against mortgage fraud,

the law doesn’t outline how the state will pursue any charges unless the evidence falls from the

sky into the lapse of state prosecutors.

44 OKLA. STAT. ANN. Tit. 21, § 1500 (West 2008). 45 http://mlis.state.md.us/2008rs/billfile/sb0217.htm. 46 MD. CODE ANN., REAL PROP. § 7-401 et. seq. (West 2008).

The Legislation and Policy Roundtable Volume 1, Issue 2, Spring 2009

46

Even with banks more watchful in the wake of the subprime fiasco, no public institution

currently audits any meaningful portion of mortgage applications to ensure the well-being of the

purchaser, lender, and the state.

To their credit, the Indiana legislature recently created a mortgage lending and fraud

prevention task force, staffed by state employees across various departments and regulatory

agencies responsible for aggregating the individual agencies’ reports, policies and

recommendations about mortgage fraud.47 It is not a huge stretch to see this as an appropriate

activity for an agency of the federal government. More appropriate still would be an effort on

the part of this same task force to conduct investigations and audit mortgage applications, similar

in both purpose and practice to the income tax audits performed by the Internal Revenue Service

and other federal tax authorities.

But the current federal efforts to counteract the effects of mortgage fraud are inadequate

and halfhearted. The federal government seems as hamstrung as Minnesota and California by

the daunting task of enforcing any such measures. It took the federal government until July of

2008 to enact PL 110-289, which requires the reporting of confirmed or suspected fraudulent

mortgages on a case-by-case basis.48

But the law only applies to mortgages upon their purchase or sale, not at any point during

the origination process.49 In other words, rather than even going so far as to delegate

responsibility to the lenders themselves to protect the homebuyers who will be their sources of

income, the federal government has thus far apparently decided that such protections are not

feasible.

47 IND. CODE § 4-6-12-2 (2008). 48 12 U.S.C.A. § 4642. 49 Id.

The Legislation and Policy Roundtable Volume 1, Issue 2, Spring 2009

47

Under current federal law, with no complement to § 4642 geared towards the origination

process, a lender can lend to a homebuyer with no effort to discover whether the application is

dishonestly written, nor indeed any duty to report the application even if they make such a

discovery. If, an undetermined time later, the resulting mortgage is sold as part of a security (or

individually), there is a duty to report the suspected fraud, but isn’t that a little late in the game?

One may recognize in the statute the larger effort to protect the economy from the

dangers inherent in mortgage securitization, and this effort is to be applauded, but how does the

federal government owe less of a duty to the individual purchasers of the exact same fraudulent

home loans that must be reported under this law?

Conclusion: Congress Must Take Action

So how prevalent is mortgage fraud across the country? It is time to stop endlessly

asking this question and get an answer. Congress must, as soon as possible, take several steps.

First, create, by legislation, an independent agency with regional branch offices tasked

with auditing as many home mortgage applications as possible from a wide range of real estate

markets to ensure that they accurately reflect the buyer’s ability to pay;

Second, fully fund this agency’s administrative costs as an investment in the future

economic viability of the mortgage industry, investors in mortgage-backed securities, and

American families in every state; and

Third, enact stiff criminal and civil penalties for fraud committed during the loan

origination process, using Maryland’s tough new law as guidance, along with the proposed

modifications.

The Legislation and Policy Roundtable Volume 1, Issue 2, Spring 2009

48

This plan should satisfy even the opponents of government spending and federal bailouts.

The administrative costs of such an agency will be miniscule compared to the money saved in

the future by both private actors and the federal government by minimizing the economic risks

associated with shady mortgage practices. The new oversight will also reduce, and hopefully

even eliminate, the necessity for such interference as the administration’s $75 billion mortgage

rescue plan in the future.

How much exactly will the risks and costs be reduced? No one knows until the agency

itself, or one like it, finally makes a fact-based assessment as to the prevalence of fraudulent

mortgage applications and their impact on both homeowners and investors. But even the

slightest effectiveness, enforcement and deterrence would result in the agency paying for itself

almost immediately.

Finally, in anticipation of the tired argument that any form of regulation will make it

harder for homebuyers to obtain mortgages by reducing lenders’ incentive to grant them,50 the

legislation should be carefully drafted to apply only to cases in which fraud was present in the

loan application process. No single homeowner will be less likely to obtain a non-fraudulent

home loan under this plan. As for the decreased availability of inadvisable home loans obtained

with the aid of unscrupulous estimations of the buyer’s ability to meet their financial obligations,

the mortgage market will likely survive the hit. Even the most fervent self-described champion

of the free market is unlikely to defend a homeowner’s “right” to be victimized in such a way.

This legislation will cost the taxpayer very little, save the government from having to bail

out banks and individual citizens, save American homeowners from financial ruin, and impose

upon no one but those engaged in criminal activity. The consequences of not adopting these

50 See, e.g., Brief for Competitive Enterprise Institute et al. as Amici Curiae Supporting Respondents 16, Watters v. Wachovia Bank, 550 U.S. 1 (2007), and Bachus, supra note 3.

The Legislation and Policy Roundtable Volume 1, Issue 2, Spring 2009

49

protections have been financially devastating to homeowners, investors, the federal government

and the economy as a whole. It is time for Congress to correct a wide array of wrongs.

Afterword: What Real Action Looks Like

It should not come as a great surprise that someone else came up with the idea of federal

civil and criminal liability for mortgage fraud long before me. Bill S. 1222 of the 110th

Congress, a duplicate of the sponsor’s identical bill of the previous year, was introduced in the

United States Senate on April 25, 2007.51 Aptly named the STOP FRAUD Act, it is by far the

most ambitious plan to combat mortgage fraud that has come out of the federal government,

including new grant programs for state and local law enforcement agencies,52 $25 million for

housing counseling,53 and the creation of mortgage fraud as an affirmative defense in a

foreclosure proceeding.54 Its sponsor showed an uncommon awareness of the mortgage fraud

epidemic in calling for support for the bill.

“Mortgage fraud and abuse are growing problems in this country, problems that are depriving thousands of Americans of their dream of homeownership and often their hard-earned life savings… Although the data in this area is limited,55 mortgage fraud, which takes a variety of forms from inflated appraisals to the use of straw buyers, is a growing problem. In September of 2002, the FBI had 436 mortgage fraud investigations. Currently, they have more than 1,036.”56

And he refreshingly backs up that understanding with a solid definition of mortgage fraud, and

the political will to use federal law to outlaw it.

51 110 Cong. Rec. S5086 (daily ed. Apr. 25, 2007). 52 STOP FRAUD Act, S. 1222, 110th Cong. § 8 (2007). 53 Id. at § 6. 54 Id. at § 10(a)(2). 55 How little hard data is there on the prevalence of mortgage fraud? The absence of any in the Senator’s floor statement strongly suggests that he and his staff couldn’t find any more on the subject than I could. 56 110th Cong. Rec., supra note 51 at S5106.

The Legislation and Policy Roundtable Volume 1, Issue 2, Spring 2009

50

“(a) In General- It shall be unlawful for any mortgage professional to knowingly execute, or attempt to execute, a scheme or artifice -- (1) to defraud any natural person, financial institution, or purchaser of consumer credit or an interest in consumer credit in connection with the offer or extension of consumer credit.”57

This language should have been added to the United States Code a long time ago. Simple, and in

retrospect blindingly obvious, the biggest problem with implementing it now would be that we

have already suffered a hefty chunk of the consequences of having lacked it during “the halcyon

days of mortgage fraud from 2004 to 2006.”58 But hindsight is so often the driving force behind

legislation of all types.

But it’s the next section that should really raise some eyebrows.

(b) Penalties- (1) CRIMINAL PENALTIES- Any mortgage professional who violates subsection (a) shall be fined not more than $5,000,000, or imprisoned not more than 35 years, or both. (2) CIVIL PENALTIES- Any mortgage professional who violates subsection (a) shall be liable for an amount equal to the sum of all finance charges and fees paid or payable by the natural person, financial institution, or purchaser who was defrauded unless the mortgage professional demonstrates that such violation is not material.59

57 S. 1222 at § 2. 58 Olender, supra note 29. 59 S. 1222, supra note 52 at § 2.

The Legislation and Policy Roundtable Volume 1, Issue 2, Spring 2009

51

Criminal penalties this stiff properly punish the out-and-out victimization that has

financially ruined families all over the country. Civil liability, while it could still be more

severe, provides the avenue the victims will need to put their lives back in order. And speaking

of judicial remedies for the victims, notice how else this bill sought to aid them in their pursuit of

justice.

Any person aggrieved by a violation of this section, or any regulation under this section may, but shall not be required to, file suit in any district court of the United States or any State court having jurisdiction of the parties to such suit (A) without respect to the amount in controversy; (B) without regard to the citizenship of the parties; and (C) without regard to exhaustion of any administrative remedies.60

While this jurisdictional provision may seem extreme, one cannot help but applaud it.

Make no mistake, mortgage fraud is, and more importantly should be treated by the federal

government as, a pernicious form of thievery more devastating to the victim than almost any

other kind. It is the responsibility of the people’s representatives to enact the strongest

protections against it that they conceivably can.

S. 1222 went exactly nowhere. It garnered a single cosponsor, and its entire legislative

history is the speech the sponsor made upon its introduction, and its referral to the Senate

Committee on Banking, Housing and Urban Affairs,61 the chairman of which, Sen. Chris Dodd

(D-CT), received a sweetheart mortgage deal from none other than Countrywide Financial.62

The bill was never seen or heard from again. Almost two years later, there are still no federal

criminal penalties or civil liability designed to punish the commission of mortgage fraud.

60 Id. 61 http://thomas.loc.gov/cgi-bin/bdquery/z?d110:SN01222:@@@X 62 Daniel Golden, Countrywide’s many ‘friends’, CONDÉ NAST PORTFOLIO, Jun. 12, 2008, http://www.portfolio.com/news-markets/top-5/2008/06/12/Countrywaide-Loan-Scandal.

The Legislation and Policy Roundtable Volume 1, Issue 2, Spring 2009

52

Just as unfortunately, since introducing S. 1222 to zero fanfare and almost zero support,

the sponsor of the bill has not continued to make mortgage fraud a priority in his housing plans,

which is a tremendous opportunity lost. His name is Barack Obama, and he is now the President

of the United States. We can only hope that in his new office he can still see the wisdom of all

his past efforts to get justice for the homeowners of America.